Erratic and nervous moves have been witnessed in the inter-bank bond market after the announcement of 'Jumbo' issue of Rs 40 billion Pakistan investment bonds in 3 years, 5 years and 10 years.
Auction for Rs 25 billion Jumbo issue will be held on April 28, while auction for the remaining amount of Rs 15 billion will be held on May 28.
By the weekend, yield on 10 years bond, when issued script (paper which is due for auction) is considered to be the most active paper due to its size and the higher yield it offers, surged by 10 basis point from 6.37 percent to 6.47 percent following the official auction announcement on April 19.
In the last couple of days 10-year bond recouped its losses and was last dealt at yield of 6.40 percent.
A few market players believe that the traders who are holding large portfolios in ten-year period are thought to have taken advantage of small corporate demand and joined the bandwagon by bidding aggressively to stop 10-year bonds from rising further so that it does not break a physiological barrier of 6.5 percent yield.
However, size of the trading amount was in small lots. A bank confirmed to Business Recorder that it was looking for a buyer of minimum size of Rs 0.5 billion could not find a genuine buyer.
The widening of the yield curve between the short term interest rates and the long term rates provides opportunity to banks to hedge their long bond with short term rates.
If a bank hedges 10-year bond with six-month borrowing at 3 percent plus spread, banks roughly gain interest income of 12 basis point on monthly basis.
Interestingly, it is worth noting that yield on 3-year and 5-year October 2003 paper is below the last cut off price of 4.15 percent yield and 5.15 percent yield by almost 35 basis point and 45 basis point, respectively, whereas yield on 10-year bond is comparatively higher by 19 basis point against the last cut out price of 6.23 percent.
Market estimates that out of Rs 280 billion (approximately) issued script in three, five and ten years period, banks holding of securities should be between 55 percent and 60 percent, out of which ten-year paper is worth around Rs 150 billion, of which 60 percent are held by banks, since banks are extremely liquid, while 10-year paper offers better return.
According to a money market trader, lower return on short term treasury bill is a major factor that has tightened the yield of 3-year and 5-year PIB by almost 1/2 percent against the last cut off price, as banks are avoiding further investments in long term PIBs and prefer to invest in this period to avoid interest rate risk.
The widening of yield curve is also the influencing factor that has forced the banks to invest in this tenor.
It is the talk of the town that a number of banks are stuck with large holdings. On the one hand, the return on short term is very tiny, whereas fear of inflation and lesser demand from the corporate sector is putting lot of pressure on bond prices.
One needs a big heart to bid in longer tenor and sit on long term bond when odds do not favour.
A bank's treasury official has said that some of the banks that have built large bond portfolio have been cautioned by the SBP to refrain from participating in PIB Jumbo auction. Banks are also guessing that cap may soon be applied on bond portfolio to avoid mishaps in future due to rising interest rate trend.
A Treasury head of a foreign bank says, "We are certainly watchful of the current interest rate behaviour. We have observed that the rates do move by 25 basis point on every quarterly PIB Jumbo auction announcement. Things are quite different this time.
In its latest presentation to IMF, Pakistan is projecting the inflation rate to be below 5 percent, which means that we are no more talking of 4.2 percent inflation target.
The awareness in the corporate sector has also risen to a great extent, and more knowledgeable would not easily be fooled by the banks.
"It may be pointed out that the NSS amount is around Rs 750 billion and at maturities PIB auction becomes due, the Jumbo PIB auction would be a regular feature as longer maturities cannot be funded with shorter maturities due to risk of gap."
A chief dealer of Pakistan bank was of view that if the SBP refuses to accept bids at higher rate, banks will be left with very little option, as they cannot afford to sit on high liquidity. Therefore, he expects that 10-year yields would remain below 6.5 percent.
Meanwhile, in its six-month Treasury bill auction, the SBP for the first time since October did not raise rates and accepted Rs 1 billion by maintaining its last cut off yield of 1.8413 percent. By accepting its target amount of Rs 5 billion the SBP would have raised rates by 10 basis point.
Bond traders believe that the market after making a downside attempt would soon reverse and breach the physiological level of 6.5 percent yield after the PIB Jumbo auction and would enter a new trading range between 6.50 and 6.75 percent.
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